April 7, 2017
Weekly Market Comment
“The summer’s flower is to the summer sweet,
Though to itself it only live and die,
But if that flower with base infection meet,
The basest weed outbraves his dignity:
For sweetest things turn sourest by their deeds;
Lilies that fester smell far worse than weeds.
– Sonnet 94, William Shakespeare
The TSX Composite gained 0.8% while the S&P 500 shed 0.3%.
The Federal Reserve minutes were released and they showed that most officials agree would probably begin weeding out some of the $4.5 trillion portfolio of Treasury and mortgage assets later in the year. So, not is the Fed in the process of raising interest rates but they are also looking to shrink the balance sheet, swelled from all of their Credit Crisis stimulus. The speed and form this process takes will take is not yet clear nor necessarily agreed upon. But the bigger point is that the Fed has been slowly reducing its easy money policies and that this is expected to continue.
Here is a visual of how large the world’s largest bond investor has increased its bond holdings:
The markets sold off on Wednesday afternoon soon after the Fed minutes were released but the market, ever reliant, took the negative news in stride. Arguably, the most important near-term factor for the stock market are earnings season, which begin next week. Analysts have not had such lofty expectations in years. The same is true for investors, who have bid up stock valuations to levels not seen since before the credit crisis (and by some metrics, you’d have to look quite a bit further back) in 2008.
March jobs gains were estimated to be “only” 98,000, a miss from the 175,000 expected. But at this stage of the jobs cycle when the economy is essentially at full employment (the unemployment rate fell to 4.5%), it’s more important to focus on wage growth (which was up a respectable 0.2% in March) and the employment-to-population ratio of worker-aged Americans. The latest reading rose slightly to 78.5% but is not as high as the 80.3% reached in 2007 or 81.9% record posted in April of 2000.
Our long-term favourite way to invest in oil is through the pipelines. Commodity prices move up and down but sending the goods down a pipe to far-away places is something that just keeps expanding. This week, Pembina Pipelines announced $325 million worth of new pipeline approvals which will carry about 440,000 barrels of oil per day. Here’s what we like: the projects’ capacity is already pre-sold via long-term, take-or-pay contracts. You know the saying “take it or leave it”? A take-or-pay contract is like saying “take it and pay for it, or just pay for it – but either way, you’re paying for it”. Pembina doesn’t get paid based on the value of the oil flowing through their pipes but on the volume.
A long time ago, we recall an analyst who screwed up the standard discounted cash flow formula when valuing a stock. The correct valuation would have come down materially. So what did he do? He just reduced his long-term inflation assumptions and, voila, the valuation remained the same! Yes, sometimes we human beings start with a conclusion and then emphasize data that supports that conclusion while de-emphasizing or ignoring data that argues against it.
Last month, Morgan Stanley published a research piece on their new social media IPO darling Snap. They released calculations that resulted in a $28 per share valuation, only to realize they made some glaring mistakes in their financial models. Corrected, the new valuation was lower but they still held onto their $28 valuation!
Analysis isn’t usually this arbitrary but it it’s always a good idea to take analyst targets and financial models with a grain of salt, focusing more on their analysis of the company today and past trends.
Musings Beyond The Markets
Published in Harper’s in 1939, this essay was written by the Princeton educationalist Abraham Flexner who managed to convince a billionaire family to fund unencumbered and unscripted research at his university. When asked by one of the newly hired professors “what are my duties?”, Flexner surprised the professor by answering: “You have no duties – only opportunities.” Princeton’s experiment ended up attracting war-fleeing scientists from Europe, including Albert Einstein. From the essay:
“Thus it becomes obvious that one must be wary in attributing scientific discovery wholly to any one person. Almost every discovery has a long and precarious history. Someone finds a bit here, another a bit there. A third step succeeds later and thus onward till a genius pieces the bits together and makes the decisive contribution. Science, like the Mississippi, begins in a tiny rivulet in the distant forest. Gradually other streams swell its volume. And the roaring river that bursts the dikes is formed from countless sources.
I cannot deal with this aspect exhaustively, but I may in passing say this: over a period of one or two hundred years the contributions of professional schools to their respective activities will probably be found to lie, not so much in the training of men who may tomorrow become practical engineers or practical lawyers or practical doctors, but rather in the fact that even in the pursuit of strictly practical aims an enormous amount of apparently useless activity goes on. Out of this useless activity there come discoveries which may well prove of infinitely more importance to the human mind and to the human spirit than the accomplishment of the useful ends for which the schools were founded.”